Editorial

MIT Needs a Principled Response to the Current Economic Crisis

(The present communication is largely based on a message I sent on December 18, 2008, to MIT President Susan Hockfield and Provost L. Rafael Reif.)

Like other academic institutions, MIT is facing serious challenges caused by the current economic crisis. The leadership of the Institute has reacted laudably by seeking an “MIT way” to address the problem based on creative thinking, faculty participation, a long-term vision, and the preservation of the core values and mission of the Institute.

While the details of the plan will unfold in the months to come, some broad parameters of the strategy have already been communicated. These include progressive cuts to the operating budget of the Institute, by 5% in FY10 and by larger amounts in subsequent years. Ways will be sought to achieve these cuts so that MIT will emerge as a strong institution from the economic crisis, but clearly no unit, program, or operation will be spared the pains of becoming leaner and adjusting to the new economic realities.

This note aims not at suggesting specific solutions but at framing what an “MIT way” out of the crisis might be and how to draw the line for the budget cuts. The focus is on broad principles and priorities not dollars and cents, perhaps to the point of being overly simplistic in the financial arguments. My own background, in risk analysis and probabilistic modeling, certainly biases the reasoning. I hope that others will join the discussion and contribute different perspectives.

My main concern is that several broad-scale considerations were missing when the rationale for the cuts was presented to the faculty and that the faculty participation in molding that rationale has been limited. In the months to come, there will be opportunities for faculty engagement, but if the overall parameters are already set, rethinking the broad picture will be difficult.

All comments are made in the spirit of open discussion set forth by the administration.

I shall focus on three issues: the technical way in which basic decisions about the operating budget are made, the large uncertainties about the future of the economy, and the importance of non-financial considerations. Out of this, a suggestion emerges on how MIT could address the crisis.

1. Technical Way in which Broad Decisions Are Made

How have the proposed cuts been arrived at? The overall objective of asset management at the Institute is to balance between two goals: having smooth short-term fluctuations in the operating budget and guaranteeing a steady long-term growth of the endowment. The former objective is usually achieved by using algorithms (such as three-year averaging, weighting of the previous-year budget, etc.) that in ordinary times act as shock absorbers for the financial ups and downs. As presented, the 5%, 10%, … cuts for FY10, FY11 and beyond came from applying one such algorithm to scenario projections of the endowment over the next few years. I find this way of deciding to be inadequate on several grounds, all of which are ultimately related to the large fluctuations of the financial markets in recent months and the extreme volatility that is likely to endure for some time to come.

Formulas that work well under normal conditions cannot be expected to remain optimal under extraordinary circumstances. These are indeed extraordinary times, in which all the parameters of decision-making are different: the ability to borrow money is diminished, the frozen job market makes any layoff a tragedy, increases in tuition close the door to financially less-privileged students, etc. In addition, we are entering a new territory with significant nonlinearities; for example, on some scale a 10% cut to a program might be not two but 10 times as painful as a 5% cut. Algorithms that work well when the fluctuations are small and the consequences are linear and financial in nature must be revisited, making sure that the large uncertainties on the future of the economy are included (the endowment scenarios used to justify the cuts are hardly representative of these uncertainties) and a wide range of consequences to the people and the Institute are accounted for.

The possibility of dipping into the endowment or financing the deficit should be part of the equation. The optimum solution will likely be different from that of say a three-year averaging rule. MIT certainly has the brainpower to formulate and solve this complex and multi-faceted optimization problem.

One could stop here and rely on the power of modeling and analysis to set the course. However, as any modeler knows well, the results of an optimization problem are driven by the boundaries within which one seeks the solution and by how one assesses the financial and non-financial consequences of any given action. I start with some remarks prompted by the large uncertainties on the future of the economy and later add non-financial considerations.

2. The Large Uncertainties on the Future of the Economy

As indicated above, one of the Institute’s main concerns is its long-term financial stability. Hence it is important to understand how different adjustments to the budget over the next few years might affect that stability. Consider the value of the endowment at some future time, say the end of FY10. My uneducated guess is that the value may likely be $1 billion above or below any best estimate one might produce right now. For example, if the current value is $7 billion and one projects no change as the most likely scenario, the actual market value of the endowment at the end of FY10 might well be $6 billion or $8 billion. By comparison with this wide uncertainty range, the proposed cuts ($50 million for the first year) are small. Suppose that the $50 million could be taken out of the endowment. If the $6-8 billion uncertainty range on the endowment applies when no $50 million cut is made, then if the cut is made the uncertainty range becomes $6.05 to $8.05 billion – hardly a perceptible change. Of course the effect of the cuts over a longer time period would be larger, but so is the uncertainty of our forecasts; so the qualitative conclusion stands, that in spite of our efforts to maneuver it, the boat follows the current.

For another order-of-magnitude comparison, consider the daily fluctuations of the stock market. Fluctuations of 1-2% have become routine and hardly make the news. If the endowment changes by say ±1% daily, that is ±$70 million. Hence what we are talking about is making (painful) cuts that amount to the daily ups and downs of the endowment.

One could easily criticize my analysis as mixing apples with oranges because the endowment is not made of liquid assets. But the point I want to make is that, if the near-term shortfalls can be covered at least in part by dipping into the endowment or through some form of financing, the Institute could avoid making large cuts during the crisis without jeopardizing the long-term financial picture. Repaying the debt and making large adjustments to the operating budget could take place at more prosperous future times when the Institute and the people affected could better afford them.

3. MIT’s Mission and Moral Responsibilities

Non-financial factors should feature prominently in MIT’s response to the economic crisis. Among them are the wellbeing of the people at MIT, the mission of the Institute, and the moral responsibilities we have towards the academic community and the society at large during these difficult times. If there is an “MIT way” to deal with the present crisis, that way should be framed to a considerable extent by these concerns.

Let me amplify on a couple of points. At times of general economic distress, it is in the general interest that all who are able to survive the short-term turmoil do not make cuts or at least do not make synchronized cuts. This is the familiar situation when what seems optimal from the perspective of individuals at the time of decision-making does not produce the overall optimal solution (optimal not just for the society at large, but for the individuals themselves, in our case because of the worsening of the general economic climate and the down-spiraling feedbacks caused by everyone moving in unison). Rather, at a relatively small cost, MIT could set an example for other (wealthy) educational institutions to follow and declare that for the good of all it is making no deep cut. Such bold posture would pay back handsomely in reputation, future donations, etc.

What do I mean by “deep cut”? The Institute is forming a broad-based task force to review and streamline all MIT operations. This initiative will produce reductions in the operating budget that I view quite positively. Where the cuts get “deep” is when additional significant savings are mandated, possibly affecting academic programs, faculty hiring, support staff, student support etc., unless these cuts are viewed as reasonable by the pertinent units.

Consider for example the issue of faculty hires. The projected reductions in the operating budget would lead to a virtual freeze in tenure-track hiring, with long-lasting repercussions on the intellectual strength of the Institute, its ability to steer into new directions, and its ability to renew its ranks. While no hiring freeze has been announced by the administration, budget cuts on the order of 10% or 15% will inevitably reduce hiring to a trickle. This would happen at a time when young new talent finds reduced opportunities in academia because of the few available openings. By continuing hiring at the normal pace, MIT could distance itself from other peer institutions, help the new ranks in the academic profession, and attract top-quality individuals with little competition.

In summary, for various internal and external, financial and non-financial reasons I find the proposed cuts – especially after FY10 – to be unwise. I would favor budget reductions to reflect gains in efficiency at all levels and in all Institute endeavors, but would withhold making deeper cuts unless the general economic conditions worsen significantly. Any residual deficit could be covered by a combination of dipping into the endowment and financing. More critical than a balanced budget at this time is to safeguard the core values and mission of the Institute, its outside image, and the wellbeing of the people who make MIT the unique place it is.